A principle referring to the static price relationship, given a stock's price, between the prices of European put and call options of the same class (i.e. same underlying, strike price and expiration date). This relationship is shown from the fact that combinations of options can create positions that are the same as holding the stock itself. These option and stock positions must all have the same return or an arbitrage opportunity would be available to traders. Any option pricing model that produces put and call prices that don't satisfy put-call parity should be rejected as unsound because arbitrage opportunities exist. The above illustration demonstrates a simple put-call parity relationship. Looking at the graph, we see that a long-stock/long-put position (red line) has the same risk/return profile as a long call (blue line) with the same expiration and strike price. The only difference between the two lines is the assumed dividend that is paid during the time to expiration. The owner of the stock (red line) would receive the additional amount, while the owner of the call (blue line) would not. However, if we assume no dividend would be paid to stockholders during the holding period, then both lines would overlap.
The exercise of a put option. Put to seller would usually occur when the strike price of the put is lower than the market value of the underlying security. At this point, the seller would have the option, but not the obligation to sell the asset to the option writer for a higher price than what is currently dictated by the market. For example, consider a situation where an investor buys puts to hedge downside risk in his or her position in stock A. The investor buys three-month puts on A with a strike price of $25 and pays a premium of $1.50 (for example). The put seller or writer who earns the premium of $1.50 assumes the risk of buying A from the investor if it falls below $25. Towards the end of the three-month period, if stock A is trading at $22, the investor will sell stock A to the put writer, and receive $25 for each share of stock A.
An investment strategy that combines options to create a spread which has limited loss potential and a mixed profit potential. It's created by combining long and short puts in a ratio such as 2:1 or 3:1.
An option strategy in which an investor owns shares in the underlying stock and writes more at-the-money call options than the amount of underlying shares owned. The goal of a ratio call write is to capture the premiums received by the option sale. The call writer hopes that there is little volatility in the underlying stock over the same period.. In ratio call writing, the ratio represents the amount of options sold for every 100 shares owned in the underlying stock. For example, a 3:1 ratio call write implies writing three call option contracts (a total of 300 call options) and being long one hundred shares of the asset. The payoff from holding the asset and writing the calls resembles a reverse straddle. The profit range for ratio call writes is often very narrow. A large drop in price may end up costing the trader a considerable sum of money. If the price of the underyling shares increases too much, the trader will lose. There is no limit to the potential downside with an increasing underlying price.
A single option linked to two or more underlying assets. In order for the option to pay off, all the underlying assets must move in the intended direction. The underlying securities can have different characteristics, such as expiry date and strike price, but all must move in the way the option holder has bet they will. Here's a sports-betting analogy that demonstrates a rainbow option: suppose you're at a baseball tournament with three fields backing one another. One game is halfway through, a second is just starting and a third starts in an hour. A type of bet that's analogous to a rainbow option is one that earns you a profit if you pick all three winners, but gets you nothing if any one team you pick is a loser.
A finance and risk management technique based on a put-call parity strategy that consists of selling a put and buying call (a synthetic long position), while shorting the underlying stock. As long as the put and call have the same underlying, strike price and expiration date, a synthetic long position will have the same risk/return profile as ownership of an equivalent amount of the underlying stock. In a typical reverse-conversion transaction, a brokerage firm short sells stock and hedges this position by buying its call and selling its put. Whether the brokerage firm makes money depends on the borrowing cost of the shorted stock and the put and call premiums, all of which may render a return better than the money market with very low risk. In the context of futures markets, a trader would be synthetically long and short the underlying futures while looking for arbitrage opportunities.
A substitute for a swap arrangement that is terminated before it matures. A swap may be ended early if there is a termination event or a default. If a swap is terminated early, both parties will cease to make the agreed-upon payments and the counterparty who caused the early termination may be required to pay damages to the other counterparty. A replacement swap is likely to have different terms, or interest rates, than the original swap since market conditions usually will have changed. As such, the damages (called “termination payments”) will factor in the difference in interest rates between the original swap and the replacement swap.Possible termination events include legal or regulatory changes that prevent one or both parties from fulfilling the contract terms (“illegality”), the placement of a withholding tax on the transaction (“tax event” or “tax event upon merger”), or a reduction in one counterparty’s creditworthiness (“credit event”). Failure to pay or a declaration of bankruptcy by either party are examples of default events. To give a real-life example, when Lehman Brothers declared bankruptcy in 2008, entities that were involved in swaps with Lehman had to seek replacement swaps.
A clause in a lease that outlines the terms for renewing or extending an original lease agreement. The renewal option appears as a covenant in the original lease and provides specifications under which the leaseholder can renew or extend the original lease term for an additional, specified time and rate (rent). A renewal option provides the leaseholder the option, but not the obligation, to renew or extend a lease agreement beyond its initial terms. A start-up business may, for example, rent an office space for five years. A renewal option would allow the business to renew or extend the lease to remain in the office space beyond the five-year lease term. This can be beneficial to the business: if it is doing well in the location, it can remain for an additional term; if it is doing poorly, it can close shop at the end of the initial term without defaulting on the lease and without pressure to renew or extend it.
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